The Italian financial newspaper “Il Sole 24 Ore” reported today that Koering, the French-owned conglomerate which controls some of the most renowned and revered luxury brands in the world, such as Gucci, Bottega Veneta, Saint Laurent, Pomellato and others associated to clothing, jewelry, bags and other luxury products, settled a tax case with the Italian tax agency pursuant to which it will pay to Italy the record amount of euro 1.250 billion in assessed and unpaid income taxes and penalties relating to the period 2011-2017.

The case originates from a criminal inquiry started by the Italian tax police (“Guardia di Finanza”) in the month of December 2017, and was closed on November 27, 2018 with the recommendation to the criminal judge to charge the current and former president and chief executive officer of the Italian company Guccio Gucci S.p.A. with the crimes of tax evasion and failure to file Italian income tax return. Under Italian criminal code, failure to file a tax return when due is independently classified as a tax crime, whenever the unpaid tax due exceed a certain threshold (currently set at euro 50,000) and is punished with imprisonment for a minimum of eighteen months up to a maximum of four years. The general manager of the company who should have filed the tax return is personally liable for the crime. The general provisions of the criminal code would still require criminal intent, but criminal investigators and judges often issue the charge for the crime, leaving it to taxpayers and prosecutors to argue during the criminal proceedings and at trial about the actual existence of the criminal intent, which is a mental state difficult to prove or disprove and often inferred form the circumstances of the case.

The facts of the investigation concern Guccio Gucci S.p.A., the Italian operating company of the group, and Luxury Goods International S.A., a Swiss company of the group based in the Canton Ticino of Switzerland (the predominately Italian language canton sitting at the border with Italy).

Years earlier, the Italian company, owner of the GUCCI brand, had licensed the brand to the Swiss company, together with the rights to exploit and manage the brand for the purpose of the global marketing, commercialization and sale of GUCCI products in Italy and worldwide. According to the investigators, however, most of the marketing activities for the distribution and sale of the GUCCI products actually took place at the premises of the Italian company in Milan. As a result, the investigators took the position that the Italian company, in fact, operated – and should be re-characterized – as a “silent” or undeclared permanent establishment of the Swiss company, and all of the profits of the Swiss company that are attributable to the activities carried out at its “silent” permanent establishment in Italy should be subject to corporate income tax there. In addition to that, the investigators also challenged the transfer prices charged between the two affiliated companies in respect of the license and use of the brand.

A permanent establishment in Italy is subject to the same corporate filing requirements as an Italian incorporated entity, and, for tax purposes, it is treated as a separate taxpaying entity with the duty to file an Italian corporate income tax return, report its Italian taxable income and self-assess the Italian corporate income tax due. int must keep Italian financial books and file a financial return which is the staring point for the calculation of its taxable income in Italy.

As reported in the news, the taxpayer settled the separate tax audit with the Italian tax agency for the amount of 897 million euro in taxes plus interest and penalties for a total amount of 1.25 billion euro, which is a record amount for similar tax cases in Italy. It is worth noting that a criminal tax case and a related tax audit are independent and follow separate paths. The settlement of the tax audit does not automatically terminate the criminal case, which will run its independent course (and will be ultimately decided by a criminal court according to its own interpretation and application of relevant tax law concepts to the facts of the case). The taxpayer’s strategy is that the prompt settlement with the tax agency (and the big bill that will be paid to the Italian Treasury), will help helping the taxpayer to prove its good faith, disprove any criminal intent and ultimately avoid harsher criminal penalties.

Koering is controlled by the French billionaire Francois-Henry Pinault and has a total revenue of 13.6 billion euro and EBITDA of 4.4 billion euro for 2018.

We do not know all of the details of the facts of the case, and we cannot elaborate on the reasons why the taxpayer did not decide to fight the criminal case and related tax audit in court. However, unless the facts were egregiously bad or investigators had found the proverbial “smoking gun”, the circumstance that the case was immediately settled at the outset is telling about the realistic approach taxpayers and their tax advisors sometimes prefer to take, when facing the pressure of a criminal inquiry often used as a tool to extract a quick settlement and the high degree of uncertainty of any possible litigation in court.

On this particular tax issue, the recent decision on the “Dolce & Gabbana” case should probably have offered more comfort and perhaps the incentive to face the inquiry and challenge the tax audit in the tax court. However, that was not the taxpayer’s ultimate decision, and, unfortunately, we will be deprived of the opportunity to hear what the tax department of the Italian Supreme Court would have, and the Court itself will miss the opportunity to right some wrongs of the past and restore Italy’s reputation in front of the international tax community.

Indeed, the attempt to re-characterize a duly incorporated entity as a branch is considered an extreme departure from a fundamental principle of law, which requires that the corporate form be respected, as long as some minimal corporate formalities are met, and is very well settled in the US legal system, where it finds its binding precedent in the decision of the US Supreme Court in the Moline Properties case (Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943).

Such an egregious departure from such a fundamental principle of law is often met with disgust and contributes to the perception of Italy as an unreliable legal system and hostile environment for international investors and multinational companies, to the ultimate detriment of the country.